Dynamic Insurance Decision-Making for Rare Events: The Role of Emotions

Abstract

This paper describes the results of a web-based experiment that uses respondents’ stated preferences for purchasing insurance for low-probability, high-consequence events where the probability of a loss and its consequences are stable over time. We contrast the predictions of a model of insurance choice based on expected utility [E(U)] maximisation with those of an alternative behavioural model. The majority of subjects reported insurance purchasing behaviour consistent with expected utility theory; however, a sizeable number of uninsured individuals decided to purchase insurance after learning that they had suffered a loss whereby they responded that their prior choice to be uninsured made them unhappy. In this sense, the study shows that a loss coupled with self-reported emotions linked to the loss is likely to play an important role in convincing some uninsured persons to buy coverage. In contrast, insured individuals who did not suffer a loss rarely dropped coverage.

Keywords

individual decision-making role of emotions choice under uncertainty insurance disasters

Notes

Acknowledgements

The authors thank the referees for helpful feedback on this paper. Sergeant Shriver and John Sperger provided excellent research assistance. Support for this research comes from the Travelers-Wharton Partnership for Risk Management Fund, the Center for Risk and Economic Analysis of Terrorism Events (CREATE) at the University of Southern California, the Zurich Insurance Foundation, and the Wharton Risk Management and Decision Processes Center project on “Managing and Financing Extreme Events.”

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